Rent v. Owning Your Home, opportunity cost and running some numbers

The saga of trying to sell our house in this unfavorable market continues. We have just lowered our price yet again. If it sells, I have a great degree of confidence we will have sold at the absolute bottom. We’d be thrilled with that. To see why, let’s play with some numbers.

It does mean you ought to be clear on your reasons and not let yourself be suckered into a false reality. It means you might want to run the numbers.

Some people love the sense of ownership and enjoy working on their property. Neither apply to us, but maybe that’s you. That’s fine. We can understand.

We’ve owned a couple ourselves over the years. Sometimes for schools and an environment for raising our daughter. Sometimes just because we liked the house. But never thinking we were making an investment, let alone a good one. That’s folly.

Other times we’ve rented and enjoyed the freedom and flexibly that lifestyle offers. Sometimes we’ve been both landlord and tenant at the same time, arguably the best of both worlds.

Now renting is the direction to which we are ready to return. But we’ve never made these choices without first considering the costs. You might want to do the same. Using our numbers, here’s how….

The apartment we’ve targeted will cost us about $2000 per month, $24,000 per year.* Built into that are a few extra expenses we’ll pick up not owning. Winter storage for my motorcycle and summer storage for the car’s snow tires, for example.

Our house is on the market for $355,000 and after commissions and fees we’ll net around $330,000. (This is lesson #1. Buying and selling houses is expensive. Unless you are sure you are ready to settle in for a number of years, rent. End of story.) We are mortgage free.

Opportunity Cost

With $330,000 equity tied up in the house the first and largest expense to consider is “opportunity cost.” That is, simply, what could this money be earning elsewhere? Right now it is locked up in the house and earning zero interest or dividends.

Here we need to select a proxy. In your own analysis, you might use whatever you plan to invest in. Or, if you are renting and considering a purchase, whatever you currently have your soon-to-be tied-up-in-the-house money invested in.

I choose VGSLX, which is the Vanguard REIT Index Fund, because I intend to move the money here to maintain my asset allocation in real estate once the house is sold. Since VGSLX pays a dividend of about 3.5% the opportunity cost is $11,555 (330k x 3.5%). That is, VGSLX would pay me $11,555 per year while the house pays nothing.

Capital Gains

Of course, the house might rise in value providing me with capital gains. But VGSLX has this same potential. In actual point of fact, the fund is the more conservative investment. Here’s why:

VGSLX is a broad based fund holding investments in numerous properties all across the country. The house is a far more focused holding: one property in one neighborhood in one town in one state. As such it could provide greater or lesser gains.

During 2011 VGSLX rose about 12% while my house value continued to slide. 2012? Who knows? Maybe the house will outperform.

Since this is unknowable, as predicting the future always is, and since the investments are both real estate, we can for this analysis treat the potential as equal. Clearly if you strongly believe your house or the alternative investment will do better you can factor this into your thinking.

Running the Numbers

$11,555 opportunity cost. This is the 3.5% dividend our 330k could be earning in VGSLX.

$29,555 total annual cost of owning and operating the home. Pretty shocking, no?

v. $24,000 rent =

$5,555 annual premium to live in the house.

Now looking closely you’ll notice, while the apartment saves us $5,555 per year, there is an $6,000 cash flowadvantage to owning the house. It takes 24k in cash outlay to rent the apartment but only 18k cash to operate the house.

This is similar to the EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) for a business. Cash flow is critical in running a business or your household. But the ITD&A are all real costs that you need to consider in an accurate fiscal evaluation. So is opportunity cost.

Overall costs trump cash flow costs, simply because they are more complete.

There you have it, the most fiscally precise way to compare the real money costs. Just plug in your own numbers.

Running the Numbers another way

But wait, some will say, owning the house saves you $24,000 in rent. Isn’t that like an investment return?This is a bit clumsier, but sure, we can approach it from this direction.

If you have a mortgage, and many do, you simply need to add an extra couple of numbers to the formula. Let’s take a look.

Suppose I had 20% equity ($66,000) in the house and an 80% mortgage of $264,000.

$2310 opportunity cost. This is the 3.5% dividend our 66k could be earning in VGSLX.

$23,795 in cash expenses comes from these:

$2500 heating oil. Heat is included in the apartment rent.

$7000 maintenance & repair & insurance

$8500 real estate taxes

$10,560 estimated interest on our mortgage loan @ 4% (note: the portion of your months payment that is applied to principle should not be included for this purpose although you will want to add it to calculate your cash flow number)

-$4765 tax deduction savings. This assumes a 25% tax bracket and includes the real estate tax and mortgage interest above.

$26,105 total annual cost of owning and operating the home.

v. $24,000 rent =

$2105 annual premium to live in the house.

Because you have a mortgage your cash flow cost is now up to $23,795.

Bottom line.

So, even selling at the market bottom I come out ahead. I can handle the higher cash flow and that $5,555 in annual savings is real money in my pocket. Plus I get to step into the blissful renter’s life again.

BTW, while owning your own house is a lousy investment, investing in rental houses can be a whole other and very profitable thing. As alluded to above, at one time many years ago I was both a renter and a landlord at the same time.

These days investment real estate is too much like work for my tastes. But there is money to be made if you are willing to make the effort.

Post Script:

In the rent v. own analysis there are several formulas that provide some rough guidelines as to which is fiscally better. Here are two:

1. House price/Annual rent.

If the result is 21+ renting is better

Between 16-20 it’s a toss-up

less than 16 is a vote to buy

Using our number: $330,000/$24,000 = 13.75 This says we should buy, or in our case stay put.

2. Monthly rent x 110 = house price.

If the house costs more, rent. If less, buy.

$2000 x 110 = $220,000. This one says no question, rent.

So maybe these are not much help.

More useful, I think, is to look at actual numbers for a given situation as we did above.

“Life choices are not always about the money,

but you should always be clear about the money choice you are making.”

*Turns out I vastly over estimated the cost of our apartment. Rather than $2000/$24,000 per month/year, the number I used in the post scenarios, the actual rent is $1415 per month, $16,980 for the year. Since these numbers are only used as an example to illustrate the concepts, I don’t feel the need to recalculate them in the post. It is the technique that matters and in applying it you’ll want to use your own numbers anyway.

Some have observed that my examples above are not an Apples v. Apples comparison. Indeed they are not. But this only becomes an issue if you are looking at it as an academic exercise designed to prove a “winner” in comparing renting v. owning. I don’t.

In my opinion it is far more useful to compare two actual choices someone might be considering, and the framework I’ve provided here is designed to do just that. I’ve simply used our situation as the example.

You might be currently living in an apartment and considering buying a house. Or, like us, you might own a house and be considering renting again. Running your own number comparison will tell you what each option you are considering will really cost. You can even compare houses at different price points.

People make choices in the real world and running the numbers in the fashion I’ve offered lets them see precisely the financial implications of their choices. If they care to.

Having said that, should you be interested in what the numbers look like if we compare owning v. renting my specific house, check out my February 26, 2012 conversation with Executioner in the comments below. In my reply I run those exact numbers and you can see the same framework used in a direct apple v. apple comparison, again using our house as the example. It works either way.

The point is not that you should rent. Or that you should own. The point is, it is worth understanding the financial ramifications of your choices. Doing so positions you to make a more informed decision.

Once you have a sound handle on the numbers, you are also in a better position to evaluate the various lifestyle issues, deciding what such things are worth to you.

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Comments

Interesting analysis! I always roll my eyes (hopefully people can’t see me) whenever someone repeats the mantra “Your home is your biggest investment!” No.. investments make me richer! My house is just a place to live. Everyone needs somewhere to live and some people just prefer houses.

The opportunity cost is an interesting angle and it changes the whole game. That’s actually one reason why we opted NOT to pay off our house and instead buy the rentals. Our mortgage is at 4.75% and our rental portfolio is yielding 24% (albeit, with some input of time on our part). The math was easy 🙂

I’m not so sure about the numbers on this… even with opportunity cost factored in. Then again, I’m from Australia so the figures might be slightly different.

In my home town (Brisbane), I can buy a house in a nice area outright with the $500,000 available to me, or I can pay $400 per week to rent it and invest the difference. (This is an actual example, not just a made up set of numbers)

Assuming a “safe withdrawal rate of 4%” to prevent ever eroding the value of the $500k, if I were to choose the option to rent and invest the difference, I can only use a maximum of $20,000 (plus inflation) per year for rent. Which is pretty much exactly the same as the house costs to rent. The problem is the $20k I made through investing the difference is subject to tax and therefore I need an amount somewhat larger than $500k to be able to afford to rent the same place.

For argument’s sake let’s say I need $600k… suddenly I forego the opportunity cost of an additional $100k to rent instead of buy.

So it appears in my case it’s ended up being cheaper to buy the house, even accounting for the additional ongoing expenses (taxes, maintenance, etc.).

I’m not familiar with the US real estate market, so it may make more sense to rent over there. But unless I’m missing something it makes less sense to rent in Australia, despite the apparently overvalued housing market.

Timely post, as I’ve been going through this argument in my mind and on paper (as I do calculations).

I’ve come to the overwhelming conclusion, that while buying will likely come out ahead monetarily for me if I stay in one place for 10+ years, However, I don’t really like the idea of being chained to a location (and house) for that long. 10 years is a long time in one person’s lifetime, as life is relatively short.

I like the idea of one day living off my dividend income and perhaps traveling to low cost locales like Ecuador, Thailand, the Philippines and what not. Being tied down to a house in hopes it appreciates and sells so that I can go somewhere is uninteresting at best, and sickening at worst. And, even if I don’t travel and stay in the United States once you’re no longer tied to a specific geographical location through employment…then you’re really free to come and go as you please and that’s a freedom that I’m willing to pay a premium for through renting.

There’s always the option of renting out a house, but who wants to worry about landlording when you’re off living a wonderfully exciting life somewhere 5,000 miles away?

I don’t enjoy cutting the grass, painting walls, customizing a living room, landscaping, impressing neighbors, being tied down to one location, being tied down to an object or having most of my net worth tied up in one illiquid asset that is slowly falling apart.

I have a post under construction about this, but renting for the fiscally disciplined is always the more profitable choice.

Your plan of living in various places around the world matches ours exactly. We spent last summer in Ecuador and highly recommend it. Wonderful place. This year we’ll be in Peru and Bolivia. My wife loves her job but working for the schools at least she has the summers off.

Our daughter was in Thailand a couple of years ago and raves about it. Sounds a bit hot and humid for our tastes, but she had a great time and loved the people.

As for the Philippines, the son of a pal of mine recently married a Philippine girl. They traveled there to meet her family and he’s been talking about moving there ever since.

There are a lot of very cool places to visit in the world. Beats the hell out of mowing the grass.

I’ve owned a lot of homes, starting with the cottage in Ireland on an acre – that cost me 2000 pounds.(US 4000.) With the romantic stream. (Of course, it had no plumbing, but hey-)
Bought another farm in Ireland for 5000 pounds (US 10,000.) An acre, 2 storey – and plumbing! Coupla outbuildings and barns…and an acre of bog.
Then there was the villa in Spain, gorgeous view of the Mediterranean, bought for $28,000. (Furnishings were an extra $3000.)
These were pretty easy purchases. No mortgages. Few costs.
Between now and then, I’ve sold or bought (I think) 18 properties. Still own 5 of them. Maybe 6.
Still no mortgages.

And yet – after all that – I agree with your post! With few exceptions, buying a house, unless you like houses and don’t need a mortgage – is a responsibility. I just understood real estate better than I understood funds. I never did the homework – or had your blog to read! If I had, I might not have bought the houses! (And yes, I do have the VTSAX now—)

Still have 3 rentals here in NM. But I wouldn’t have done it if there had been a mortgage involved. And yes, you’re right on the European ones…
Of course, if you want to put in plumbing, it’s best to own the place.
And the absence of plumbing didn’t deter the previous owners from raising 14 children in the house. We had different priorities.

Overall, good. I like the places, would live in any of them myself. I use an agency, so I don’t deal with too many of the issues, and I bought them all at a good price.
The other houses? I live in one, and the other is a cabin in the Jemez mountains!

Just playing devil’s advocate here…how would the numbers look if you had done this comparison using the rental price for your house, instead of an apartment? How much would you charge someone to rent your current home from you?

I wonder if running this comparison between a $330K home and an apartment might not be exactly apples-to-apples.

It sounds to me like you’re gaining some of the “renting advantage” simply by downsizing. Couldn’t you gain a similar advantage by selling your large house and buying a smaller condo? I think you’d see extra cash flow in that scenario too, without bringing rent into the equation.

You make an excellent point and, in fact, we can look at this with some precision. A few months back someone looked at the house and made an offer to rent it @ $2500 per month, 30k annual. This seems a fair rate and it does make your point that some of the benefit we’ll realize is from downsizing. Here are the numbers:

$11,555 opportunity cost. This is the 3.5% dividend our 330k could be earning in VGSLX.

What I’ve tried to do with this post is to provide a framework for others considering the rent/buy issue. What makes most sense is to plug in the actual numbers for a specific situation and see what comes up. I just used ours as an example. Make sense?

BTW, congrats on “executing” your mortgage last year. Great feeling, that! Where in NH are you?

I’m a newcomer to your blog coming over from MMM. I’m really enjoying it! As an engineer I always appreciate a numerical approach to finances and feel that you do a great job of taking a numerical approach to your financial advice.

While I agree that in your position and example here, you will be making a great move (or maybe already made? I’m over a year later here…), I had a different take on this “apples to apples” comparison you just made.

Using the expenses you mentioned before, the cost of renting your house were stated as $32,500. 3.5% in the VGSLX would make your cost of owning and living in the house $29,555. In this case owning the home is $2945 cheaper than renting.

In the second scenario with an opportunity interest rate of 5.5%, the cost of owning increases to $36,150, but you then compared it back to the less expensive apartment (at $24k). The “apples to apples” comparison says that it’s only $3,650 more expensive, not $12.5k.

I’m closer to the beginning of my career and have many years to save. My family is also still in the growing phase, so I’m looking for houses that are about the same size as the one we are renting; hence my interest in this apples to apples comparison, since we don’t want to downsize from the house we are currently renting. If we were renting your house, it would cost us $32,500. If we then bought your house we would be paying $18k to live in it, and freeing up the $14.5k difference would have cost us $330k. That’s an effective rate of about 4.4%.

That’s not a bad rate, and it would be a guaranteed return, but I have many years until retirement and am expecting to get a better average return from my Vanguard index fund than that. Add in the costs of buying and selling a home and renting becomes more and more attractive.

The take home is that it is different for everyone, and running the numbers, in addition to other “real-life” factors that are not necessarily financial, is definitely the right thing to do. In the end, everyone should just be aware of how much their choices and lifestyle are costing them, and then they can choose however they want!

“Using the expenses you mentioned before, the cost of renting your house were stated as $32,500. 3.5% in the VGSLX would make your cost of owning and living in the house $29,555. In this case owning the home is $2945 cheaper than renting.” I’ve now corrected that in my reply to Executioner. Thanks!

As for the second scenario, you can certainly look at it in a the more apples-to-apples comparison. And given your personal situation, that makes perfect sense.

But I’m more a believer in comparing apples-to-oranges as that better reflects the decisions we make in the real world.

(for more see my conversation with SC below)

For instance, as it turned out, my apartment only costs me $1415 a month rather than the $2000 I had budgeted.

Of course you are right that buying and owning a home is not just a financial decision. That’s why I owned houses for 28 years. For more along those lines you might enjoy:

I have seen the argument against home ownership from an investment standpoint before, and while I tend to agree, there is one thing I don’t understand.

First of all, it can’t be a losing proposition to own, because if it was then you wouldn’t be able to rent. Because nobody would bother owning properties and renting them out.

Now, you may say “well, rental properties are a different story”

OK, But if you buy a house, what are you doing if not just renting to yourself? The best, most reliable tenant you could get?

For example, Lets say you took the $330,000 from the sale of your house and instead of the REIT you bought a rental property. Most people would say that is a good investment (as long as the particulars of that house were sound).

But what is the point of owning a house, renting it to somebody else , and renting ANOTHER house, from somebody else, for yourself?

How would your calculations change if you counted yourself as a tenant, and ran the numbers for home ownership that way?

great to see you over here and thanks for commenting. great questions!

It is possible to think of your house as an investment and yourself as the tenant. That is a bit what we do by approaching it with my second set of numbers above titled:

“Running the Numbers another way”

Or you could take a look at the numbers in my response to Executioner below for another take.

Owning rental properties becomes an entirely different thing because of the actual income received and the tax deductions.

Let’s say I view myself as a tenant in the home I own and even pay rent to myself into a separate account. From this account I then pay the operating expenses. That’s fine as far as it goes. But the IRS isn’t going to want to hear it come tax time.

If instead, I rent to you all of those expenses are now deductible and I can also take a depreciation deduction as well. Then you buy the same house across the street and rent to me. You can do the same.

Another issue is the type of house. Our home, in mint condition and at it’s price level, doesn’t offer an investor the same opportunities as a more modest home in need of some repair. You can see this very clearly in Dollar Disciple’s post (see link above)

If not for these two factors, you are absolutely correct. Personal or rental, the investment evaluation would be the same. But these are pretty big factors.

From your description, you are going from a house to an apt. Renting will usually be cheaper because the equivalent housing value is lower. Where I live, the average home goes for 750K. The apt I have looks like a bargain in comparison when you compare monthly outlays, but if the apt could be priced at market it will would be much less than half the average home. So, renting beats owning because you are “buying” less property.

In many parts of the country, owning is cheaper when comparing it by market value. I wonder if you could rent your same house, would it still be cheaper?

To “6-Figure Investor”:
That’s an aspect of buying or owning that so few people consider: Maybe you really don’t NEED the 3 car garage, the extra media room, the fitness room or the 5th bedroom…!
When I buy a house as a rental, I always make it a small one – there will always be a market for a small (and hopefully cute) stand-alone house in an area around hospitals and universities.
Big simply costs more. If you buy it – or rent it – make sure you need it. There’s always a cost involved.

Good thinking. My wife and I are also thinking about downsizing as my daughters have gone to college. We have a huge house(over 9000 sq feet), which we don’t need for two of us. I’d rather invest my money wisely than to pay mortgage.

Hi JLC – found you from MMM and really appreciate this post. I had never questioned the economics of owning vs. renting, I guess just because of that pervasive ‘American Dream’ attitude. I will be much more conscious of the tradeoffs and definitely run the numbers when my time comes, so thanks for opening my eyes!

Love those final metrics. I made my way over here from MMM’s wonderful site, and am slowly reading all your back articles. Currently renting in Japan, and doing the math our target house price divided by current and (forseeable future) rent is over 100!!!

I submit that there are some intangible benefits to owning that will never show up on a rent/own comparison analysis. These have to do with stability and flexibility.

Stability:
– Rent can increase
– Landlord/Property Manager can go bankrupt, die, decide not to renew the rent, decide to sell, forcing you to move

Flexibility:
If you are a renter, it is much more difficult (if not impossible) to do the following:
– Cultivate and harvest natural resources from your land (timber, crops, livestock, etc)
– Add-on or remodel at will (add a garage, plant a tree, repaint the interior, add energy-saving improvements, build a shed, destroy a shed, knock down a wall, add a window, remove a door, build a moat and drawbridge, and so on)

I also re-iterate the point that I’ve made on many blogs in the past (including yours I believe) that if you rent, you are indirectly paying the landlord’s taxes, insurance, and fees. Those costs are unavoidable. The only thing you can avoid as a renter is maintenance costs in the short term, although in the long run you’ll probably end up subsidizing them through your rent payments too.

Finally, if you value privacy and elbow room, it’s a lot more difficult to find a rental property without neighbors on all sides (often sharing walls or floor/ceiling).

I’m not saying it doesn’t make sense to rent. However I don’t think it is quite so straightforward as running a financial analysis and going with the cheaper result.

Regarding your comments, we are mostly on the same page. There are many non-finacial reasons to buy a house, and to rent. Depends on individual needs and preferences.

My main point is that running the numbers provides an objective measure of what the comparative cost will be. since most people don’t bother they are unaware of the real cost of their house purchase and rely on the propaganda of the real estate industry.

Having run the numbers I KNOW my house costs me $5-6000 dollars more each year than the equivalent apartment. Raising my daughter, especially in this school district, made that extra expense worthwhile. Now, not so much.

Oh, and RE taxes, repairs and maintenance can and do rise very bit as quickly as rent.

When you get your moat and drawbridge finished, let me know. I’d love to take a ride up to see them! 😉

We are currently renting. But since we live in Texas renting is actually more expensive than a mortgage. We are currently saving for a 20% down payment. Want to buy a small 3 bedroom/2 bath home. In Dallas, TX they range from $130k to $150k. Our goal is to put down 30K.
I’m still not sure whether we should choose a 15 yr or 30 yr mortgage. We could afford a 15 year mortgage, since that and taxes will equal what we pay in rent. But a lot of people (adults who are more financially stable than us) have told us to get a 30yr mortgage, and invest the rest of the money.
What’s your opinion?

Ordinarily, I’d say go with the 15 year and get it done ASAP. But these are not ordinary times. These are times of extraordinarily low mortgage rates.

If you are absolutely certain you have the discipline to invest the difference and leave it invested for the long term, go with the 30 year mortgage. You can always accelerate your payments and turn it into a 15 year or less if you choose.

But if you have any doubt at all about relentlessly investing the difference, stick with the 15 year.

If you would, please let us know what you find and how the deal comes together!

We are not going to be buying until late 2013. According to my time table, this is when we will have saved our 20% down payment, and have enough of other savings to feel comfortable to purchase our home. Plus that’s when our lease ends.
I am pretty disciplined when it comes to investing and I’m positive we will invest the difference. I will let you know what comes of it when we get close to the home buying deadline! Thanks for your advice!

I’ve also found that during my tenure as a homeowner, I always have a desire to “improve” the house. A new fence here, a back up sump pump there, etc. Those costs don’t neatly fit into the maintenance and repair category and I doubt I’ll get my money back upon sale. They also add up over time. During my rental years, I never had a desire to spend a dime fixing up my landlord’s place. I also never had to take time away from more desirable pursuits to mow the grass or call multiple contractors to get bids to fix a problem with the house. In retrospect, my wife and I always seemed happier while renting. Perhaps I’ll return to that lifestyle one day.

Great post, I just found this after writing our own take on Rent vs Own for the Seattle area. The tax deduction from mortgage interest may work out to be less advantageous than presented, since a married couple filing jointly has the option of taking the standard deduction; $11,900 in 2012.

This would make the mortgage interest deduction only a $2,930 reduction in taxes instead of $5,900, although it depends on what other itemizable deductions you may have (state income tax or sales tax, donations, income tax prep fees, etc…)

We estimated owning was at least a $1,000 a month increase! Like Dividend Mantra above, we didn’t want a piece of real estate tying us down when we started traveling permanently. 6 months in, so far so good!

Other advantages, in the apartment we paid $0 annually for maintenance, didn’t need to own a ladder or a lawn mower, and our weekends were completely free of maintenance duty. Paying $1,000 extra a month to live in more space than we need, comes with uncertain maintenance and repair responsibilities, is further away from the places we buy groceries and hang out with friends, and places obligations on more of our free time seemed to be a poor trade

and an outstanding point about the tax write off so widely touted. The truth is, the standard deduction is very generous. At $11,900 it takes a pretty big mortgage/RE tax bill to go over it. And even then the only advantage is the excess.

So, if your house gives you itemized deductions of say, 14,900, the home ownership tax deduction advantage isn’t 14,900. It is the difference between the two: $3000.

Even at the 25% tax bracket, and as a married couple you’ve got to be over about 90k in AGI to get there, your tax savings in $750. I spent more than that on snow plowing this year. And that’s not deductible!

Yep, sold! We move April 3 and close on the 8th. More about that to come.

Your point about needing $90k of AGI to take advantage of the mortgage interest deduction is an interesting one. With a national median income of about half that, a couple would need to be in the top 20% in order to get any benefit.

It’s not quite as gloomy as he makes it out to be. Let’s take a couple making $50k and living in one of the 41 states that imposes income tax. They’ll be in the 15% bracket, but also paying (say) 5% in state taxes. Using that 14,900 number for RE tax+mortgage interest (which puts their house somewhere in the ~$200-$250k range I believe), and adding the $2.5k state tax, we get $825 of benefit…more than his $90k couple in a no-tax (and no sales tax, apparently) state.

It’s an academic exercise, though. If you’re buying a house just to be able to itemize your deductions, you’re doing it wrong. I bought my house because (1)My PITI is half as much as it would cost to rent an equivalent house, (2)It was appraised significantly higher than the purchase price, and (3)I genuinely like working on it and upgrading it to my standards, which I could never do in a rental. Heck, even when I was renting I would usually be the one fixing stuff instead of calling the landlord, so there have been very few downsides and lots of upsides in my case.

I noticed that many people buy a lot more house than they really need (or previously rent) just to cover all the future possibilities (junior will drive his own car one day so let’s get the three car garage just in case even though we currently only have a single automobile) and then put a lot more stuff (which tends to be a lot nicer and therefore a lot more expensive) inside just because they can and then eventually stretch themselves thin and pay much more than they would if they rented.

Then on the other hand, if you rented all this cash lying around (because it does’t go into a mortgage) might lead to silly purchases of silly consumer goods, therefore the “opportunity cost” of having the cash tied up in a house instead of hard cold cash might not be as great as one thinks it woud be…

You have to make sure you are comparing apples to apples and not apples and oranges. I think Executioner pointed out one error. Is the apartment rental for $2,000 a month really equivalent to your home in terms of size, neighborhood, condition, etc? I suspect your house would rent for more than $2,000 a month- so the costs are probably about the same.

Another advantage to owning is that you can change the property anyway you like. You can paint, remodel, etc. You can’t do that with a rental.

For me, it is a no-brainer to own. My house is worth about what yours is, but my taxes are only 2800. I think you said yours were 8500? Ouch. We have natural gas and last year it was about 600 bucks. Home prices in my area are appreciating, interest rates are very low, and I plan to stay put for 10-20 years or more. Why would I want to pay someone else’s mortgage when I can pay my own and build wealth? I understand the opportunity cost of the equity, but the implied rental value I’m getting, plus appreciation, plus tax deductions, far outweigh the opportunity cost of that money in my situation.

1. Apples v. Oranges only becomes an issue if you are looking at this as an academic exercise. I don’t. The framework I’ve provided here is designed to compare two actual choices someone might be looking at and I used our situation as the example.

Having said that, if you read my response to Executioner you can see the same framework used in an apple v. apple comparison, again using our house as the example. It works either way.

People make choices in the real world and running the numbers in the fashion I’ve offered lets them see precisely the financial implications of their choices. If they care to.
BTW, as it happened our rental cost turned out to be only $1415 per month. $2000 was my best estimate at the time, so that’s what I used.

2. Theoretically you can change your property any way you chose. But the reality is that if you stray too far from accepted norms your property values will take a major hit. Moreover, those norms change frequently. The tasteful stainless steel appliances and granite countertops you install today might fall from favor and cost you money tomorrow. Almost any real estate professional will caution that remodeling to increase value is tricky and requires very careful planning. Even done well, the payback rarely reaches 100% of the cost. But this only matters if you are concerned about the financial aspects of owning. If not, sure. Do whatever you like.

3. If you’ve run the numbers and you are comfortable with what they tell you, enjoy your home!

In fact, I’d say the same even to those who haven’t run the numbers and don’t care to. And to those who have and don’t care what they say. I’m not the least bit interested in persuading anybody about anything here.

As for index funds, what I can promise you is that they and the rest of the market will be hit by crashes and bear markets multiple times over the decades to come. Your resolve will be tested. Guaranteed.

Those will be the times that determine who makes money and who doesn’t. Warren Buffett won’t be panicking and running for the exits. I won’t be either. (I made that mistake in ’87) My fondest hope is that the readers of this blog, knowing full well such events are to be expected, won’t either. They’ll stay the course and be richly rewarded. Including you.

Is the apartment rental for $2,000 a month really equivalent to your home in terms of size, neighborhood, condition, etc? I suspect your house would rent for more than $2,000 a month- so the costs are probably about the same.

It’s important to separate the “investment” part of owning a property, and the “expense” part of living in a home.

Everyone has housing expenses. Everyone pays rent. If you own a home, then you’re paying rent to yourself.

Let’s say that you’re right, and Jim’s house would actually rent for more. For the sake of argument, let’s say it would rent for $2,500. Well, then, by moving to the new apartment, Jim has reduced his housing expenses by $500 per month, or $6,000 per year.

By selling the property, Jim has reduced his gross rental income by $30,000 per year. But he’s also reduced his expenses by $18,000 per year. That’s $12,000, which coincidentally is about the same amount of money that Jim could earn from investing in VGSLX. And there are extra expenses in owning a property that someone else lives in.

So even at a $2,500 estimate, Jim comes out ahead in two ways. He reduces his housing expenses by $500 per month, and he moves his equity into an investment which is more liquid and has higher returns.

Now, if Jim’s house could fetch $3,000 per month, then you start to get into the territory where it would make sense for him to keep the property as an investment. But at that estimate, the case for renting becomes even more obvious; Jim’s new apartment will save him $1,000 per month in housing costs!

Good advice – I will think twice now about leaving a job where the housing and utilities are provided in order to go build a house. I also appreciated the calculator you included showing percentage of savings to years it will take to retire. This has made me seriously re-think my current situation…

I’ve been poring over these numbers since hearing your analysis. One question though, wouldn’t the equity in your home rise with inflation? This would give you an approximate 3% gain annually, and so your true opportunity cost would only be the 3.5% from your dividends minus 3% inflation of your home price for a total of 0.5%. I did some net present value calculations to compare 30 years of owning vs. renting. Being able to sell the “asset” in year 30 makes the extra on-going costs of buying moot. Although you then have to find another place to live, so maybe the calculations are different for a perpetuity.

Certainly a house could rise in value over time, as could the proxy. I discuss this in the post above:

“Of course, the house might rise in value providing me with capital gains. But VGSLX has this same potential. In actual point of fact, the fund is the more conservative investment. Here’s why:

VGSLX is a broad based fund holding investments in numerous properties all across the country. The house is a far more focused holding: one property in one neighborhood in one town in one state. As such it could provide greater or lesser gains.

During 2011 VGSLX rose about 12% while my house value continued to slide. 2012? Who knows? Maybe the house will outperform.

Since this is unknowable, as predicting the future always is, and since the investments are both real estate, we can for this analysis treat the potential as equal. Clearly if you strongly believe your house or the alternative investment will do better you can factor this into your thinking.”

Let’s say you have a 33% tax rate and are renting a similar home (not apartment).

$0 heating oil will be the same for both homes
$7000 maintenance & repair & insurance (seems high to me for a $350k house, but we’ll go with it)
$5,695 instead $8500 on real estate taxes – Assuming you itemize deductions
$12,695 total cash expenses =

(Comparable house is $30k to rent, not $24k for an apartment as mentioned)
$17,305 positive cash flow in house, minus

$7,626 instead of $11,555 factoring in taxes on the dividends =

$9,679 annual investment surplus, i.e. cost of house over renting.

(note that this doesn’t include capital gain taxes that you would owe on VGSLX either)

But the first thing you want to take note of is that the government allows everybody a Standard Deduction. For 2013 it is $12,200 for married filing jointly and $6100 for singles.

So looking at my personal example of no mortgage, even living in a state with an exceptionally high RE tax of $8500, I am no where near itemizing. So owning provides -0- tax advantages.

That’s how I handled it in the post’s first scenario.

However, in the second scenario we assumed a mortgage and did in fact include the tax deduction:

$8500 real estate taxes
$15,120 estimated interest on our mortgage loan @ 4% (note: the portion of your months payment that is applied to principle should not be included for this purpose although you will want to add to to calculate your cash flow number)
-$5905 tax deduction savings. This assumes a 25% tax bracket and includes the real estate tax and mortgage interest above.

Of course, given the standard deduction I have overstated the tax advantage benefiting the homeownership numbers. More accurately:

That’s a even less than the $5905 tax deduction savings I originally calculated at only the 25% bracket. BTW, the 25% bracket is good up to $$223,050 (married filing jointly) in adjusted gross income. Single is 25% up to $183,250.

It looks like your last calculation neglects the leveraging effects of a mortgage. With 20% down, if your house appreciates by 3%, your equity goes up by 15%. With your numbers, that 3% would be around $10,000. Even supposing that the investment you are missing out on had the same 3% gain, that is only on the 66k – about $2,000. So, on a 3% rise, your calculation misses $8,000 on the plus side for buying – enough to flip the verdict. Of course, leverage increases risks on the downside, too. Prices may or may not return to their historical upward trajectory. But it is clear that the rent/buy decision is far more significantly affected by expected house price movements than your calculation suggests.

I think you may have missed the “Capital Gains” section in the post? In part it reads:

“During 2011 VGSLX rose about 12% while my house value continued to slide. 2012? Who knows? Maybe the house will outperform.

“Since this is unknowable, as predicting the future always is, and since the investments are both real estate, we can for this analysis treat the potential as equal. Clearly if you strongly believe your house or the alternative investment will do better you can factor this into your thinking.”

As you observe, leverage is a two edge sword. Failing to understand this is one of the things that brought so many to grief when the housing bubble collapsed.

That said, if you have reason to believe the price of a house you are considering will go up (or down) in value, you can certainly factor that into your calculations.

Just be sure you are basing your assumption of appreciation on some tangible factors rather than wishful thinking. As a point of reference the historical appreciation of houses is ~1%.

Where did you get the figure of 1% as the historical appreciation of houses? And even at 1% it should consistently contribute $3300 to the ‘own’ side of your equation.

I prefer your apples to apples version for comparing the financial wisdom of buying a home versus renting. I agree with your comments about making choices on how you want to live and spend your money. I would be interested in the numbers had you bought a more modest home (comparable to the apartment in size and quality). But mixing a financial argument with lifestyle and value choices, clouds the financial comparison in my view. Clearly renting a small apartment is less expensive than buying a bigger house. I’m not sure that needs to be proven.

In your section “What about mortgage interest payments?” you compare renting to a purchase with 20% down, however in your specific case you would have been able to reinvest the $264,000 (equity) with projected returns ranging from 3.5% (up to 5.5%) for a conservative increase of $9,240 to owning. This would make the smaller apartment a $7105 premium over the larger home.

I disagree with your view that a home is not an investment, but perhaps that is simply a matter of definition. Is a savings account an investment? CD’s? Regardless, I think we agree there is a financial component to home ownership that can be financially advantageous and people must understand more accurately how they compare before deciding to buy or rent.

It would be interesting to see all these qualities compiled into a comprehensive buy vs rent calculator.

We definitely agree that the ‘dream’ of home ownership has been over sold and a home purchase should be far more of a financial decision than it actually is. We need to help people find the right place, time and circumstances that allow a home purchase to be a financially sound choice.

Hi Jim, love this analysis(and your site). One question – should you be comparing your $330K home to a small apartment? Wouldnt it be more “apples to apples” in comparing a similar townhouse/condo to the apartment? One could argue that you have more space and features in the house than the apartment(as well as the added expenses).

In our case, we have children and pets. We were renting a similar detached home. As the rent was $2500 it turns out to be much less expensive for us in owning a similar home(around $300K). In our case, the utilities are equal in both options. However, if we were sans children and dogs and planned to travel many months of the year, I would certainly opt for a cheaper alternative.

There was also the feeling we had in the rental. A sort of uneasiness that the manager could up our rent or evict us at his choosing.

Apples v. Oranges only becomes an issue if you are looking at this as an academic exercise. I don’t. The framework I’ve provided here is designed to compare two actual choices someone might be looking at, and I used our situation as the example.

Having said that, if you read my response to Executioner above you can see the same framework used in an apple v. apple comparison, again using our house as the example. It works either way.

People make choices in the real world and running the numbers in the fashion I’ve offered lets them see precisely the financial implications of their choices. If they care to.

Once you have a sound handle on the numbers you are in a better position to evaluate the lifestyle issues, deciding what such things are worth to you.

Sounds like you’ve not only run the numbers, but lived both options as well. 🙂

If owning the house is both less expensive and better for your needs, well done!

I think you are better off – safer – if you treat the house as a house, not an ATM or a savings account or an investment. Basic rule: If you are not willing and able to sell an asset in 5 days (settlement period) you don’t own it. Move it into the net worth column of your kids. This is true for a lot of hard assets (which are peculiarly soft, financially speaking) like guns, jewels, collectibles, as well as houses. The other point about hard assets that needs to be hammered home is that they are a rich field for self-delusion. They are so illiquid that you think they are worth what a neighbor said at a cocktail party; or a half-remembered Sunday Supplement article may have said if your memory serves; or what you paid for them; or “goodwill;” or “great growth prospects;” or what the county assessor has hoked up as a ‘valuation’ in order to increase your taxes. Never value any of them at more than your cost; and you’ll be better off to set them at zero (“$0.00″) in your annual financial retrospective and your future projections. Review Graham – an investment is an operation that upon mathematical analysis promises safety of principal and regular paid returns. A house doesn’t make it unless you are renting part of it out. Pay it off ASAP with heavy infusions of cash flow (NOT principal) from other real investments while the loan is young and either 1) drop it out of the net worth if you are going to live in it, or 2) make it a rental while moving to a smaller place. If you transmute it to a rental you may restore it to the net worth column.

This advice is sound partly because if you follow it, the surprises you get when you sell out of a particular hard asset will be positive, or at least non-negative.

“Pay it off ASAP with heavy infusions of cash flow (NOT principal) from other real investments while the loan is young”

You favor paying off your home with the returns of your other investments versus re-investing those returns?

If the house is draining say 3.375% (my mortgage rate) and stocks “return” say 7%, wouldn’t it be wise to “net the difference” by paying the minimum monthly mortgage payment? Paying it off early locks in a 3.375% return where taking cash flows that would be used to pay it off early and invest in the market would produce a 7% return.

Perhaps this is a “make the best of it scenario” meaning one shouldn’t buy a house in some instances. But if you do, and lock in a low rate, shouldn’t one “make the best of it” and ride out the “cheap money”?

In other words, I’m sure banks would prefer that I pay off my 3.375% loan so they can loan it out at today’s rising rates, for the same reason I should want to “hold onto it”, now that I already have it.

Just an observation regarding the Post Script. To recap briefly the two methods are
1. If House price/Annual rent is 21+ renting is better, 16-21 it’s a toss-up, less than 16 is a vote to buy
2. Monthly rent x 110 = house price. If the house costs more, rent. If less, buy.

MDM, we were thoroughly confused by the same issue. I went to comment and saw that you beat me to it. Perhaps we could conclude that a ratio of under 10 is a strong sign to buy, and a ratio over 21 is a strong sign to rent, and the “toss-up” range is WAY bigger than expected? 😉

I love the article – it’s great how it includes opportunity cost. It’s funny how whenever you talk to people about this subject they seem to assume that owning is better, even though they typically never look at the numbers!

I have a question about the mortgage interest rate that you mention. You include:
15,120 estimated interest on our mortgage

But where did you get this number? If I use a mortgage calculator with 4% interest over 30 years I get a total of $189,735.50 interest. If you average that out over 30 years that’s only $6,324.50 per year.

What you are missing is that interest on a mortgage is paid out as a yearly average. Instead the mortgage payments at the beginning are mostly interest with a bit of principle. Over the years,this shifts as the amount owed is slowly paid down. Toward the end the monthly payments go mostly to principle with a bit to interest.

In my example I used the interest/principle from the first years as we are comparing own v. rent at the start. In the later years the amount of annual interest would drop and the equity would build as would the opportunity cost of having that equity tied up.

Yes, that makes sense. Except….it looks to me like the interest in the first year would be $10,475, and then decreasing over time until the last year only $322 would be paid in interest. So, the numbers I’m getting still aren’t as high as your estimated $15,120.

It seems to me that you would want to consider the number of years you expect to pay the mortgage. Otherwise your estimated interest costs would be higher than what you would actually pay in interest over the course of the mortgage (since it decreases over time).

I believe I have two other observations that I haven’t seen any comments on.

First, the opportunity cost would increase over time. As you pay the principal down, you keep increasing the amount of money invested in the house, so your opportunity cost would continually increase. (…giving renting a bit more advantage over time)

Secondly, over the course of many years you would see your rent increase quite a bit, whereas the mortgage cost is essentially locked in at the start. (…giving owning a house a bit more advantage over time).

…now you have me wondering just how I arrived at that $15,120 figure in the first place. Usually with a mistake like that I can see how it was made, but after a fair amount of pondering, I’m at a loss, and I’m surprised nobody caught this before. The post has been up over two years!

In any event, I’ve refigured and updated the numbers:

Interest on $264,000 at 4% comes to $10,560 on my calculator. Plus I had to refigure the tax savings which now drops to $4765.

Net result: $2105 premium to live in the house.

Of course, as I pointed out in Addendum IV:

I also vastly over estimated the cost of our apartment. Rather than $2000/$24,000 per month/year, the number I used in the post scenarios, the actual rent is $1415 per month, $16,980 for the year.

Since these numbers are only used as an example to illustrate the concepts, I don’t feel the need to recalculate them with the actual rent in the post. It is the technique that matters and in applying it folk’ll want to use their own numbers anyway.

Thanks for the fact-checking. Let me know if I got it right this time!

1. Yes, opportunity cost will increase over the time you own the house. Both as you pay down the debt and if/when the value rises.

2. Over time, assuming a non-deflationary environment and the absence of rent-control, rent can be expected to increase. But one of the advantages of renting is flexibility and the ease of moving. Should a given apartment, city, state or country become too expensive relocation is simple.

Personally i think the owning is better if you have a good finance to buy a own house and if not,then renting is better..it’s good describe you the opportunity cost which even i don’t know proper about that.

The takeaway is of course that its prudent to run the numbers on any investment decision. All investment decisions have opportunity cost.

I can see how some are getting the feeling that you are advocating for renting rather than buying. Of course its not always a clear cut as that, as you admit.

What you REALLY need to know is how small of a house you are willing to downsize to, find comparable rents and home values and run the three different scenarios (staying put, renting smaller home, owning smaller home) against each other. I think that is the main thing that this article leaves out.

For instance, if you’re now going to rent for $2,000/mo then figure out the actual value of the property you’re looking to rent. Then run the numbers and see if you could find similar properties selling for similar prices and compare owning the cheaper home vs renting the cheaper home.

For prudent financial planners like yourself, and ones that read this blog, I’d imagine owning is almost always possible and better as long as you don’t want a house well above $150k (depends on area of course, but average). Renting will probably still make more sense in San Francisco, Honolulu, Seattle or New York no matter how you look at it. But for the vast majority of the country, I think there is an avenue to owning that is almost always better.

So basically, if owning the house yearly + opportunity costs is cheaper than renting yearly then its better to own the house; because, like you say, everyone pays housing costs no matter what.

I have never lived anywhere that renting would cost less than buying a similar house.

My wife and I are currently renting in the Portland area. (We made the mistake of buying our last house too soon so we are renting for a year to learn the area.) Anyway, our rent is $1695 on a house that our landlord purchased less than a year ago for $260,000. We could make payment on a 15 year loan, homeowners insurance, and taxes for less than that. The New York Times rent vs. buy calculator puts our break even point at $951 which sounds about right.

One advantage of owning is the opportunity to reduce the cost of maintenance. When one owns they have the opportunity to do these things themselves and save money or pay a professional. When ones rents these will be done by professionals and the cost built into rent.

Another opportunity for savings is energy efficiency. A homeowner has the incentive to upgrade the efficiency of appliances, add insulation, etc since they are paying the utilities. On the other hand a landlord (or spec builder) has the incentive to purchase the least expensive option regardless of long term costs. Why would a landlord pay a penny more in capital to reduce operating costs since they the operating cost is passed on the the renter?

Owning also has savings if one is looking to retire early. Once the mortgage is paid off housing costs decrease dramatically. That allows for much lower monthly expenses and the opportunity to greatly scale back work or retire completely. Renting and saving the (for me non-existent) savings does not offer that option. Rent has to be paid every month with after tax money. Either one has to save in taxed accounts or pay a penalty plus taxes to withdraw money from tax-deferred accounts. A penny saved is worth more than a penny earned because savings aren’t taxed.

Excellent article. This week I had an offer accepted to buy a 2 bed apartment and so stumbling across this article was perfectly timed for me.

Based on some napkin math, I was pretty sure that buying was the better decision financially but I’ve just spent the whole morning making a spreadsheet based on this article to get an exact figure for my personal situation.

Buying does indeed work out better for me, even when comparing buying a two bedroom apartment against renting a one bedroom apartment (although I’ve had to guesstimate at maintenance/repair cost per annum as I have never owned property before), although this result is probably because in my area, all rents are increased by inflation annually and so renters perennially pay above the market rate unless they are prepared to move every two or so years, which is a little tedious.

My calculations have also revealed to me that it will take approximately a year before the reduced cost of buying covers the associated costs incurred making the purchase (legal fees, mortgage booking fees, double paying rent and mortgage for a month or two while we move, other associated moving fees).

Renting vs. buying always seems like a debate that people respond to emotionally, rather than logically, and we all know that emotions and personal finance is a dangerous combination!

Great to hear this post was useful to you in your recent purchase decision. My guess is that, knowing how the numbers worked you will always be more comfortable in your new place. It is always great when what you want to do is also the best financial choice.

But even if renting had been shown to be cheaper, you still could have bought.

Knowing the the numbers in that case would have allowed you to decide if the extra money was worth it. This was the case when I bought my houses. They certainly cost more than renting, but I could afford them and they were an expensive indulgence I was willing to pay for.

And, boy howdy, are you right about this subject being an emotional trigger! This post, and those I’ve linked to in it, have gotten me the most hate of anything I’ve ever written. 🙂

If you think of it in terms of a balance sheet, each time you pay off a part of the principle you increase your equity. So those dollars are buying part of the house, an assets you own.

That said, it is easy to see why it seems like a cost and, in the sense of Cash Flow, it is.

That is, that cash is removed from your pocket and locked up in the equity of your home. And that is what leads to the opportunity costs (which don’t effect cash flow but do effect your costs) discussed in the post.

I spent most of this weekend pouring over all your articles, including many of the links. Wow! What a wealth of information (pardon the lame pun!). I was particularly struck by your advice/opinion regarding house ownership. I bought a fixer-upper in a popular college town for $140,000 cash in 2010, and after sinking a another $120,000 (thanks to a mortgage) into it have a house worth close to $370,000. When I bought the house my wife and I had dreams of living in it at least 15 years. We are now 5 years in and, though we enjoy our house, are wanting to travel a lot with our 9 year old daughter. I run a small business that pays for us to live reasonably well (I’m drawing $50k p.a.), but not enough for us to travel more than two weeks once a year. Your articles were truly inspirational! We are now toying with the idea of selling our house, investing at least $200,000 of the proceeds into index funds (my company SIMPLE IRA is already invested in VTSMX), and holding at least $20,000 back in a ‘Travel Fund’.
Obviously this is a big decision to sell up and ‘risk’ our equity in the stock market, but after running the numbers it seems we could hit 60 (we are both 43 now) with approximately $1 Million in investments, which would make for a comfortable retirement! Though house prices are rising here, I can’t see us realizing that level of profit from selling our house in 17 years (especially given the on-going costs of home ownership: rising property taxes, maintenance and repairs, etc).
So, I wanted to thank you for your website, and for giving us a fresh perspective on our future. We love our house, and it has a lot of our blood, sweat, and tears in its walls. But a comfortable retirement, and the ability to travel with our daughter now, is far more compelling!

Much like Andy’s post above, I’ve spent hours reading through your articles. The information is incredible. Hat tip to you for putting this website together!

Based on the information above, I am resisting home ownership. I’m 30 years old, married and expecting our first child soon. We have $100k cash, $50k in retirement (0.53% fees), $20k in debt (Student Loans – Interest rates under 2.3%), and take home $12k per month.

We live in SD and home prices are expensive. Here is how the numbers worked out…

$600k/$23,100 = 25.97

Or

$1925 x 110 = $211,750

We were looking into buying a duplex or triplex as our first home and renting our the other units OR buying a single family home OR buying a rental property with roughly 12% cash on cash return.

BUT, after reading your blog…I’m looking into paying off the remaining debt and pumping money into VTSAX and VBTLX.

Would you suggest paying off the debt even with that low of interest rate? I’ve been told to never hold debt above the rate of inflation and debt below inflation is considered “good” debt.

Also, how do you feel about investment properties with high cash flow?

Out of curiosity what are spending on maintenance exactly? 7,000 dollars sounds like a lot of money to spend each and every year. Also, shouldn’t you calculate the size, age, and type of house (brick vs log – more maintenance) in cost vs rent? I think the main point has to do with what perspective one takes. For example, living in a home for a long time vs the freedom or option to move whenever you want.

I see this was an older article but I am just getting around to reading it now. The interesting thing is I have been trying to make the decision on whether I should sell my house for the last couple of years. I bought my house around 12 years ago and have enjoyed living here but the last little while, as you mentioned in your article, I’m just not into the whole maintenance piece. I would rather have the freedom of when leaving to travel or go out of town for a few days of just locking the door and not having to find a friend to check in to make sure things are okay or to pick up the mail and papers laying around in front, I still get home mail delivery and the community paper delivers every week (unpaid newspaper).

My situation is probably a little different from you when you sold, I live in Toronto Canada and prices have been climbing like crazy here, I wouldn’t buy my house at the price I can currently sell it. I do owe a little on the house but even after paying off all debt I would still clear somewhere around $400k. Like you I have been comparing the cost to rent versus my expenses to run my house and the income I could generate from the sale. The numbers actually work out very favourably for me, the cost to rent and my house upkeep costs are basically a wash so any income generated is a bonus.

Where I keep stumbling is its been a while since I’ve rented and was wondering how you found the change going from owning to renting? Before buying I had always rented and over the whole time I only had one place that I had issues and I ended up moving to resolve the issue.

Last week we had a circuit breaker start tripping on a regular basis. When I owned the house I would have had to find an electrician and worry about if he was competent and honest, how big the problem was and what it would cost. Renting I just sent an email to the office and a couple of hours later our building handyman was there tracking it down.

Of course, nothing is perfect. At the moment we have upstairs neighbors who are not as quiet and considerate as we’d prefer. But when the record levels of snow were falling this past winter I could just enjoy it knowing I’d never have to take a shovel to it.

In a couple of months our lease ends and we’ve started to look around at what else is available that might be fun to try. If we decide to move, no hassles staging the place and trying to sell. We’ll just hire movers and we’re gone! Wings!

First, a huge thank you for the series of articles. I’ve read almost all of them and I’m confident the concepts will become useful for me. Especially what you wrote about how to think about money.

I realize most of your discussion on this site is for audience in the US, but I wanted to give an example of a situation where buying makes sence.

We live in Helsinki, Finland (northern Europe, not Minnesota) and we are in our third purchased apartment now. The flats and budgets have been rising on every step, but the rationale is always the same. First buy an apartment that needs fixing from a reputable but not ridiculously expensive neighbourhood, then renovate it yourself paying for only the jobs your have by law, stay in it for two years and sell. The trick here is that selling your own apartment or house after living two years in it will set you free from paying taxes from the profit you’ve made. Since renovations were mostly material costs, this has provided us some nice gains.

As we have used mostly debt to buy the flats, calculating profit for invested capital wouldn’t provide very useful numbers. But one example: be bought for 180k, used 20k to renovate and sold for 280k two years later. Given the low interest rates, this deal got us out from whole bunch of expensive credit cards and some. And I would consider this as an investment, even though I’m yet to start investing in the stock market. 🙂

But the main point was to discuss another angle to see the numbers. I didn’t read all the comments, so perhaps this was already mentioned.

The point being that living costs, no matter what you do. For us, the rationale for owning has always been that the amount of money needed to be spent each month has always been lower when owning vs. renting a similar apartment from a part of the city we have wanted to live in. Downpayment, interest and maintenance costs have been lower or equal to monthly rent.

Next thing is that the money you pay as rent is going to go away from you forever. Whereas when owning, part of that money is paid for bank as interests, some to other maintenance costs, but most of it is going to reduce debt. And when we are going to sell, those payments will become liquid assets in our pockets. I see that money as saved, not invested since it didn’t gain any new value (apart from the fact that housing prices here have been rising for decades, and the renovation gains I mentioned.)

If you run the numbers and owning is the better financial choice, you’ll get no argument from me. Although, at this point in my life, I personally pay a premium for the freedom and flexibility renting offers.

Later this month we’ll be moving into a new luxury high-rise. We’ve enjoyed our two years living in the loft apartment, something I always had wanted to do, but now we are ready for a change. So easy to just let the lease end and pack up. Plus there is a two month gap between the old apartment and the new so other that storage fees for our stuff, we are rent free for July and August while we travel. 🙂

One thing I’d point out: If part of your gains in renting come from renovations you should also calculate and deduct the value of your time as well as the materials your buy. Renovating real estate moves beyond being an investment and into the realm of a part-time job.

Thanks for the article, it’s given me a new way to think about our house situation. One thing I don’t understand with your formula, you say in your example the house is a better cash flow situation as you are paying out $18,000 in expenses instead of $24,000 in rent. Wouldn’t the $11,555 a year you’re getting because you’ve sold the house, invested in Vangaard, and pocketing the dividend offset the $24,000 rent so cash flow is now $12,445 a year, beating out the owning house cost by $5,555? I’d think this makes the rental better on cost and cash flow.

Yes I see. Cash flow vs overall costs. Owning the house doesn’t make cash flow like the dividends, it’s all on paper until you sell. I see, you make decisions on cash flow depending where you are at the moment, holding the house or owning the dodo end flow, but the overall cost give a net figure.
Anyway you’ve got us thinking, we want to retire in 10 years and spend winters in the Philippines so it’s good to to the objective numbers to make it happen.

But if it had stopped paying dividends and dividends were my sole reason for holding it, I would look for another investment that better suited my needs. Or in the case of the analysis in the post above, was a better proxy in looking at opportunity costs. But VGSLX still fills that role nicely.

The opportunity cost to move closer to your job, or move to a different state on a whim is huge. Or the not having to buy lawn equipment, lawnmowers, snow blowers, etc. When your neighborhood goes to crap, you can move.

You sold homes at the bottom of the century- 2012.
Unless you dont follow market trend and news media at all for some reason, you’ve shouldve known that wasnt the time to sell.

But you could argue the liquidity move to stock market in 2012 was a best move.
Then again, depending on the mutual fund, it may get you somewhere 7-15% only where as real estate in some areas up as much as > 100% in west coast.

Hi,
I love your website and the clarity you frequently bring to “complex” concepts.
This is a great case in point, however I did not see anywhere the fact that for every mortgage payment there is an increase in principal, a bonus savings if you will. Granted this “savings” only “earns” anything once house is sold and hopefully has appreciated, but it is one of the positives of owning.
Once rent is payed the only “savings” is opportunity cost.
We own our home on a 15 year at 3%. We rent out the downstairs for $1300/m, mortgage is $2200 and to rent the part that we live in would be an easy $2000/m so we have made it work for us. The numbers made our decision easy.

Great article, I have been reading a lot on this site and it is a literal treasure trove. My wife and I are going to be making some big decisions in our immediate future and articles like this are invaluable.

I think I found your articles on why your home is a bad investment and your blogs on renting v. owning just in the right time BEFORE I put all of my cash into a new home!

I have literally NO ONE to rely on for advice on my current situation (other than ppl online or realtors, and I do not trust the realtors). So I would GREATLY appreciate it if you could offer me some solid advice.

I inherited my mom’s house that she purchased in the late 70’s and there is no mortgage. It’s a very large home on 10 acres and living here has made me realize two things: 1) I am not cut out to be a home owner because I do not fix anything on my own, and 2) I do not care about having property because I dont do anything outside except suntan (plus I loathe property taxes). BUT I LOVE privacy and nature!!
My property taxes alone are $5,000 a year. The house has never been updated or very well maintained. According to all the contractors who have seen the home, they recommend not putting ANY money into updating and just sell “as is.” The home is very outdated and it was listed for sale in 2013 with no offers. The lowest price it was listed at was $380,000. Now one realtor has agreed with the contractors and told me I should list the house “as is” for $350,000 this coming summer. Other similar homes in the area are listing for $430,000 and selling, but they have been updated and have actual farmland (mine is just 10 acres of trees) and have been better maintained. Would you agree with listing the home “as is” or do you think putting $50,000+ into updating would be better and then trying to sell at a higher price?

Initially, my plan was to downgrade and put as little as possible into a new home so I could use the left over cash to invest in stocks. But after reading your posts, I am seriously considering not purchasing and just renting. This is what I would greatly appreciate your advice on. I also loathe any visible neighbors and I have not found any property I would want to buy in my price range. However, finding a house rental that allows multiple small dogs plus has a fenced yard and no neighbors seems VERY unlikely for me to find (I cant stand apartments or condos or any city living).

Although I hate moving, I seem to do nothing but move around a lot despite my best efforts not to. So I think my dream of finding a home to stay in permanently for the rest of my life might just be nothing but a dream. So maybe I should rent instead. IF I am able to sell my home and walk away with $300,000 cash, what should I do next?

You should also be very careful in trusting the advice of people on line. 😉

That said, and since you asked, I’ll offer my thoughts.

You certainly sound like someone who would be happier renting. But given your specifications — dogs and far from neighbors — finding a rental could be tough. So begin your search now in the area you prefer and see just what is available. Renting options are certainly far more plentiful in the city

Also, be sure your landlord will be willing to respond to your calls for maintenance and repairs. Some who rent houses, especially remote houses, prefer tenants who are willing to do small jobs and routine maintenance as part of the deal.

I’d combine this rental search with a search for smaller houses to buy. After all, you are looking for the same characteristics in both cases. Plus you might find a house for sale that the owners are willing to rent to you. Selling a house in a remote area can be a long, frustrating process which could mean a more flexible seller for you.

Either way, take your time.

I absolutely would sell the house “as is” especially as you have contractors (who could make money fixing it up for you) telling you not to fix it up.

You could easily budget 50k and find it runs 2-3 times that much. Plus you have the risk of selecting a bad contractor.

My family & I have rented most of our lives but bought current house six years ago. I calculate my return on capital to be about 2.3% and my opportunity cost for our 42% down payment was a stock market that essentially doubled. Ouch. If I started today in a far higher stock market and better opportunity cost comparisons the numbers for owning would probably be more favorable. Despite all of that I really don’t have regret for buying the house. The ability to itemize taxes has been a huge windfall that far exceeds our maintenance costs. If you rent the landlord can up and kick your ass out with a few months notice. Utility costs are a wash though by owning I’m free to install all sorts of cost saving devices. Landlords don’t give a rat’s ass about your operating costs. Owning gave me the ability to tailor our down payment so that we could get our monthly expenditure for mortgage/insurance/taxes exactly where we wanted it to be. As with taxes on a house, rents can fluctuate just as easily (thou never lower) – our house tax actually dropped. If we rented this place instead of owning it our costs would markedly increase – moreso than the 4% withdrawal rule on our initial down payment. After a huge market run up last 6 yrs we’d be slightly ahead on our monthly cash flow had we invested the down payment and withdrawn 4% annually. Each year that goes by as we pay more towards principle our returns on capital should increase. All else being equal I can unequivocally say we’re happier through ownership though as Jim rightly points out there are a ton of variables.

The most important thing is that you are happier owning, and that makes it worthwhile even if it costs a bit more.

My only quibbles, and they are small, are:

—While you are certainly right that the market has had a great run over the last 6 years, we can’t assume it won’t continue the same over the next six. Can’t assume it will either. To do so is to engage in the impossible task of market timing, i.e predicting the future.

—Your ability to itemize taxes (due to your mortgage and RE taxes) is a benefit only to the extent the deduction exceeds the Standard Deduction of $12,600 you would have gotten regardless. Perhaps you have included this in your calculations, but many miss it.

Thanks – and hello from the Bahamas! You are correct, I did calculate the tax write-off that was above the standard deduction and as we had a large income during the six years that write-off was significant. I haven’t counted any appreciation in my ROC calculations and I take price quotes on Zillo as only a rough market gauge to see how we’re doing in general. We also had our first born in college at the same time and could itemize some of that (though for most part she put herself through).

I think that a HUGE key to happiness in ownership stems from the price paid and any capital appreciation. After we bought and sold our first house we rented for the next 18 years as we bounced around the world with the military. My wife and I never thought that the housing market was quite rationally priced and esp our tour in DC the prices even in 1999-2000 seemed obscene. Along comes 2008-2009 and voila! Sanity restored. Finally the cash flow to pricing made sense. I have many friends, many, who bought large homes in that high market and now they’re upside down. Anecdotal evidence is that most of those are not happy at all with owning and now many are so upside down they’re “trapped.” Can’t sell and take a massive loss so stuck in place and can’t seize career opportunities elsewhere etc.

After having done both owning and renting the absolute #1 advantage to renting I’d say is that it allows you to be extremely adaptable and flexible or to borrow a term from Nassim Taleb – antifragile. There are huge advantages especially for young professionals in maintaining flexibility. And heck, as the wife and I commence with our travel phase we may just one day return to renting and do 90 day rentals abroad – living in exotic places. :-). Absolutely LOVE your blog Jim.

As I look out my window at this cold, damp NH April day, the Bahamas sounds very nice. 🙂

Are you vacationing there, or is it your home?

You have me curious as to your itemized deductions. You mentioned you had a child in college at the time, but while some education expenses can generate a tax credit, none can be used as an itemized deduction.

So typically, unless you have a very large mortgage, high state income/RE taxes and/or generous charitable contributions, it is tough to get far enough beyond the Standard Deduction for itemizing a mortgage/RE taxes to be a great benefit.

If you are willing to share, I’d be interested in seeing what yours are. If not, no worries, but you might check for yourself.

Unfortunately it’s a vacation and the party must end in two days…. Then back to Virginia. 🙁 You are correct, my bad. Higher Ed costs weren’t itemized…. Off the top of my head (tax records are back home) it was mortgage deduction… Charitable donations to Veterans and old books to our library, long-term care ins (which as I recall was itemized) but I am giving serious thought to canceling that policy… Got it at age 49 (and I’m now 52) so wasn’t prohibitively expensive (a juicy topic for another day)… Medical costs, dental costs, health/dental insurance premiums… Add it all up and my advantage is about $3k over the Standard Deduction give or take. Mortgage isn’t all that big… $150k at 4%

OK Jim. Back from the Bahamas so I could dig into my records and give you a not so flippant answer. You asked about my tax advantages etc. I flew back to the States on a long weekend from East Europe, found a place in my desired location, distressed seller, and made my move – Call it April 2010. I made him throw in a Tommy Bahama breakfast nook table ($1500 or so) and a bunch of cabinets etc…. as Sun Tzu says – move when the moment is right:

In 2010 there was also a so-called first time homebuyers tax credit ($8000) which no longer exists. I spent about that amount on new appliances and furniture so it’s a wash. How did I get that high above the standard deduction for 5 years? A high income for those five years led to a lot of state taxes (the predominant item) and mortgage interest. I was able to add medical premiums etc. This year we are finally FIRE and I left the rat race so income will drop by about 60% and I’d guess we’ll be using standard deduction.

The major housing expense thus far has been a new upstairs HVAC – cost (-$4785). Lowers my tax advantage to $15,250. We have not sunk any major money into needless home improvements or anything…

I well realize there are different methods in calculating returns on “investment” and for the record I don’t view a home as an investment – if it works out then great – I tried to do this rationally to give us a shot at a good outcome but who knows…

My annualized maintenance costs have hovered around $400-500 other than the HVAC. I will soon have to replace the downstairs HVAC… :-(. Yes – it can gnawl at you… The MAIN advantage in buying (for us) was that I wanted to get the family into a nice place in a nice neighborhood/schools where I could set up my monthly payments at a fairly manageable level for the long haul. If we had rented we’d be in a far different neighborhood (at this current mortgage amount) or I’d be paying a lot more per month to live here and would probably still be working full time. As it turned out, had I left the $110k in the market I would have come out ahead as it stands today but such is life.

Interested in your thoughts on if my thinking is skewed or my return assumptions are off base. Thanks!

You know, somehow I’ve gotten this reputation of being anti-house. But that’s not how I see it.

I’m anti- silly people who have bought into the RE industry propaganda that it is always a good investment and who are unwilling or unable to run the numbers and see for themselves and who instead try to justify their purchase with silly notions rather than facts.

Whew! Got that off my chest. 🙂

And that’s only looking at it from the financial angle.

If someone wants a house and says “I wanted to get the family into a nice place in a nice neighborhood/schools…” and that it is just an indulgence they feel is worth spending money on, no more need be said.

That’s why I owned the houses I owned for 30 years. Just don’t claim it’s a good investment unless you run the numbers and they back that claim up.

Whew! Looks like there was a little more to get off. 🙂 🙂

Anyway, you have clearly looked at your own situation, well, clearly. Well done!

My only question would be, are your “Itemization advantage” numbers the deductible amount over the Standard Deduction or your actual tax savings?

If the latter, fine. If the former your $20,035 total is only the amount you could deduct, not the amount in taxes saved. As such, it doesn’t make sense to subtract the $4785 HVAC cost from it.

Rather, you’d need to identify your tax bracket in each year and calculate the amount of tax that extra deduction saved you and total up those numbers for your actual tax savings in dollars.

Not sure I follow (forgive me)… The “itemization advantage” I calculated by subtracting the standard deduction each year from what I actually was able to deduct counting all of my itemizations. So in the first year for example I had to use the standard deduction – no tax savings by owning – 0.00. Every year thereafter I was able to itemize well above the standard deduction – would have been impossible without the house. That $20,035 figure is the sum of only the itemized amount ABOVE and beyond the standard deduction.

Ahhhhhhhhhh! Crystal clear! Duh. 28% bracket so $5610. Subtract the HVAC and that leaves $825 which is quickly swallowed by the $400-500 annual crap that comes up. And! Still staring at HVAC #2. I won’t be having itemizations I don’t think this year and perhaps forever more. Soooooooooo I guess I’d better hope that Zillo estimate is in the ballpark! I am hoping that over time my returns improve as the % of equity in each month’s payment increases – now it’s at the rate of $283 per month twds equity and the rest are friction costs…Total Monthly = $1001.

I just ran the numbers based on where we live: (South Australia)
$15,600/pa Rent VS. $400,000 avg House price = 25.64
and
$1,300/mth Rent x 110 = $143,000. No chance we could get a house for that much anytime soon.
Things may look different in a few years once the property bubble bursts.
But for the moment, we are very happy renters in a NICE, small house. It’s just nice to see the maths backing us up. (Not to mention not having to pay for repairs, home improvements, council rates and other taxes. Yay!)

This is probably in idiotic question but I’d love an answer. My husband says buying a house is smarter because once it’s paid for, it’s paid for. Obviously we’d still pay taxes and have to maintain the house, but we’d be spending less in retirement on housing. Am I missing something super simple?